LV Thạc sỹ_The reality of credit risk management and measures to improve the credit risk management efficiency in Agribank

Factors affecting the credit risk management efficiency...3 CHAPTER III: ANALYSIS AND FINDINGS ABOUT THE REALITY OF CREDIT MANAGEMENT EFFICIENCY AT AGRIBANK, LANG HA BRANCH...3 3.1.. 3 A

Furthermore, I would like to thank Mr… and all staff in Agribank, Lang HaBranch for giving me permission to commence this report and to use the bank data.Without their assistance, and suggestions, I would have not had finished myinternship report successfully

Lastly, I would like to express my gratitude to my parents, all familymembers and all my friends who always stand by and support me to finish myreport I would like to wish them health, happiness and success

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TABLE OF CONTENTS

ACKNOWLEDGEMENT i

TABLE OF CONTENTS ii

LIST OF FIGURES AND TABLES iii

EXECUTIVE SUMMARY iii

INTRODUCTION 3

1 Rationales 3

2 Research questions 3

3 The scope of the research 3

4 Methodology 3

CHARPTER I: OVERVIEW OF AGRIBANK AND AGRIBANK, LANG HA BRANCH 3

1.1 Overview of Agribank and Agribank, Lang Ha Branch 3

1.1.1 Background and development of Agribank and Agribank, Lang Ha Branch 3

1.1.2 The organizational structure of Agribank, Lang Ha Branch 3

1.2 Overview of business activities in Agribank, Lang Ha Branch 2008-2010 3

1.3 The key term definitions 3

1.3.1 Commercial bank 3

1.3.2 Credit risk 3

1.3.3 Outstanding loan 3

1.3.4 Bad debt 3

1.3.5 Overdue debt 3

1.3.6 Doubtful debt 3

1.3.7 Credit Risk Management Efficiency 3

CHARPTER II: OVERVIEW OF CREDIT RISK AND CREDIT RISK MANAGEMENT EFFECIENCY IN COMMERCIAL BANKS 3

2.1 Commercial Bank 3

2.1.1 The concept of commercial bank 3

2.1.2 Business activities of commercial banks 3

2.1.2.1 Capital mobilization 3

2.1.2.2 Credit activities 3

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2.1.2.3 The other activities 3

2.2 Credit Risk Management in commercial bank 3

2.2.1 The concept of risk and credit risk 3

2.2.2 The types of credit risk 3

2.2.3 Credit risk characteristics 3

2.2.4 The causes and criteria to assess the credit risk 3

2.2.4.1 The causes from bank 3

2.2.4.2 The causes from customers 3

2.2.4.3 The causes from external environment 3

2.2.4.4 Criteria to assess credit risk 3

2.3 Credit Risk Management efficiency in commercial banks 3

2.3.1 The definition of Credit risk management 3

2.3.2 The importance of credit risk management in commercial bank 3

2.3.3 The Basel’s principles of credit risk management in commercial banks 3

2.3.4 The credit risk management efficiency 3

2.3.4.1 Definition of credit risk management efficiency 3

2.3.4.2 Criteria to assess credit risk management efficiency 3

2.3.4.3 Factors affecting the credit risk management efficiency 3

CHAPTER III: ANALYSIS AND FINDINGS ABOUT THE REALITY OF CREDIT MANAGEMENT EFFICIENCY AT AGRIBANK, LANG HA BRANCH 3

3.1 The reality of credit risk at Agribank, Lang Ha Branch in the period of 2008-2010 3

3.1.1 Overdue debt 3

3.1.2 Bad debt 3

3.1.3 Causes of credit risk at Agribank, Lang Ha Branch 3

3.1.3.1 The objective causes 3

3.1.3.2 The subjective causes 3

3.2 The reality of Credit risk management at Agribank, Lang Ha Branch 3

3.2.1 Credit Procedure at Agribank, Lang Ha Branch 3

3.2.2 Loan guarantee 3

3.2.3 Preventing, detecting and limiting the credit risk 3

3.2.4 Handling the bad debts 3

3.3 Accessing the quality of credit risk management at Agribank, Lang Ha Branch 3

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3.3.1 Achievements 3

3.3.2 Limitations 3

CHAPTER IV: RECOMMENDATIONS FOR IMPROVING CREDIT RISK MANAGEMENT EFFICIENCY IN AGRIBANK, LANG HA BRANCH 3

4.1 Improving the quality of credit 3

4.1.1 Mobilizing capital activity 3

4.1.2 Lending activities 3

4.2 Reducing the credit risk at Agribank, Lang Ha Branch 3

4.2.1 Classification of customer 3

4.2.2 Credit assessment and loan approval activities 3

4.2.3 Improve efficiency in collecting and using information in credit activities 3

4.2.4 Continuously improving the quality of human resource 3

4.3 Limiting the losses from the credit risk 3

4.3.1 Developing the system for early remedial action on deteriorating credits 3

4.3.2 Monitoring and recovering the bad debts 3

4.4 Some suggestions to Agribank, Lang Ha Branch, State bank, and the Government 3

4.4.1 Some suggestions to Agribank, Lang Ha Branch 3

4.4.2 Some suggestions to State bank 3

4.4.3 Some suggestions to Government 3

CONCLUSION 3 APPENDIX

Appendix 1: The figure of comparision between 2010 with 2009

Appendix 2: The Basel’s principles of credit risk management in commercial banks

Appendix 3: Ten steps of the credit procedure

Appendix 4: The 6C’s Principle

Appendix 5: Three annual business reports of Lang Ha Branch from 2008-2009

REFERENCES

Vietnamese:

English:

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LIST OF FIGURES AND TABLE

Figure 1.1: The organizational structure of Agribank, Lang Ha Branch 3Figure 1.2: Total capital of Lang Ha Branch in 2008, 2009, 2010 3

Figure 2.1: Types ò credit risk Error! Bookmark not defined.

Figure 3.1: The reality of overdue debt and overdue debt rate of Agribank, Lang HaBranch in the period of 2008-2010 3

Figure 3.2: Bad debt in Agribank, Lang Ha Branch in 2008 - 2010 Error! Bookmark not

EXECUTIVE SUMMARY

Improving the quality of credit risk management should be done immediately

by Agribank, Lang Ha Branch because the credit risk management efficiency plays

an important role in the bank activities but in fact it has some limitations Therefore,Lang Ha Branch should work out what are the effective measures for improving thequality of credit risk management, so that the branch can attain a lot of greatachievements in doing business

The purpose of this report is to provide an analysis and evaluation of thecredit risk management efficiency of Agribank, Lang Ha Branch in the period of2008-2010 This report is classified into four main chapters In the first chapter, theauthor introduces some major information about Agribank and Agribank, Lang HaBranch as well as the overview of business activities and the credit riskmanagement activity at Agribank, Lang Ha Branch Then, in the second chapter, anoverview of credit risk and credit risk management efficiency is presented Next,the analysis and findings about the reality of credit risk management at Agribank,Lang Ha Branch in the third chapter Finally, in the fourth chapter, readers will find

a lot of useful information about some effective measures to improve the quality ofcredit risk management at Agribank, Lang Ha Branch, so that Agribank, Lang HaBranch can become the successful commercial bank in the near future as well asattain a lot of great achievements to contribute to the development of Viet Nameconomy

Improving the credit risk efficiency is not an easy duty for all commercialbanks The author expects that this study will help Agribank, Lang Ha Branch andother commercial banks get the right direction to improve the quality of credit riskmanagement

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It is convinced that Bank system is regarded as the bone of the economy,reflects actually economic growth and is also affected deeply by economicupheavals During the global crisis in 2008 and the hardship in 2009, 2010 as well

2011, people witnessed that international banks in general and Vietnam’s banks inparticular fell into waves of crisis because every sector was facing with low profit,loss, slow growth due to the recession and crisis In addition, in context of being as

a new member in WTO, there are a lot of challenges with Vietnam’s economy,especially Vietnam’s enterprises which are subject to the strong competition inglobal market In this condition, many enterprises as well as individuals could notpay their loans; so, that has put a lot of banks in the dilemma situation In thisperiod the matter of the risk from the loans and how to manage well the credit riskare the top concerns for most banks

Agriculture and Rural Development Bank (Agribank) in general andAgribank, Lang Ha Branch in particular also pay special attention to the issue ofcredit risk management However, Agribank still faces some limitations in creditrisk management due to many subjective factors as well objective ones Therefore,

to overcome the difficulties Agribank, Lang Ha Branch must find out the maincauses affecting the credit risk management efficiency and the effective solutions toimprove the quality of credit risk management Discovering reality of credit riskmanagement, reasons for limitations in credit activity and finding out the solutions

to the problemsare the main objective of this study

1 Rationales

Credit is considered as a major activitiy in banking performance and topconcern by commercial banks The reason is that our country is in dire need ofcapital for investment to meet demands of newly established businesses and fordeveloped ones to expand the economic scale

It is estimated that credit brings 85% of total profit for commercial banks likeAgribank but also bears a lot of potential riskiness, even huge damage

Consequently, Agribank in general, Lang Ha Branch in particular has recently takendramatic notice of credit performance Although some considerable achievementsare reached thanks to credit risk management, there are still a lot of problemsrelated to the credit risk management that should be solved effectively In the earlymonths of 2008, the bad debt rate of Agribank in general and Lang Ha in particularhave the sign of rising beyond the allowed rate under the provisions of the StateBank So what is the reason? How to improve the credit risk managementefficiency Agribank, Lang Ha Branch? This is the top issue for Agribank boardmanagement in general and Lang Ha in particular.

In such a context, as a student who is joining the internship course in

Agribank, Lang Ha Branch, the author decided to choose the topic: “The reality of

credit risk management and measures to improve the credit risk management efficiency in Agribank, Lang Ha Branch”.

3 The scope of the research

The research is expected to give an insight about reality of credit riskmanagement at Agribank, Lang Ha Branch by collecting and analyzing figures ofcredit activity from 2008-2011, then the author will make some recommendations to

enhance the credit risk efficiency at Lang Ha Branch Therefore, the research willonly focus on the quality of credit risk management and reasons for credit riskmanagement limitations at Agribank, Lang Ha Branch, and then find out solutions

to improve credit risk management efficiency

4 Methodology

The report aims at analyzing and discover actual credit performance and thenbased on that, gives some suggestions to limit credit risk So the author decides tocarry out collecting data, figures, information by applying method of research asinterviews, primary and secondary data collection and deductive reasoning

Firstly, the author will gather information through primary and secondary data such

as annual internal reports from 2008-2011, magazines, books, professional journal,internet sites, etc to compare and summarize financial statement in Agribank, Lang

Ha Branch At the same time, during internship time, the author makes observation

on trading activities of credit management office to gain accuracy assessment

Secondly, the author also contacts with Ms Dung, the researcher’s supervisor andother employees at the branch, to arrange the direct interview with her so theresearcher can understand deeply about the credit risk management efficiency ofAgribank, Lang Ha Branch as well factors affecting the quality of credit riskmanagement

Lastly, deductive reasoning bases on logical reasoning The researcher analyzes theexternal and internal environment with the PES (Political, economic, social) theory,which point out subjective reasons for credit risk

With information collected from the above finding methods, the researcher willcomprise into the description, analysis, and comparisons to give the exactassessment and make some effective suggestions to the bank as well somerecommendations to the State Bank

CHARPTER I: OVERVIEW OF AGRIBANK AND AGRIBANK, LANG HA

BRANCH

1.1 Overview of Agribank and Agribank, Lang Ha Branch

1.1.1 Background and development of Agribank and Agribank, Lang Ha

Branch

Founded on 26 March, 1988 and operating under Law on Credit Institutions,Vietnam bank for Agriculture and Rural Development (Agribank) now is one of theleading commercial banks in Vietnam, playing the dominant role in the economicdevelopment of Vietnam, particularly in the investment for agriculture, farmers andrural areas Agribank is the biggest bank in Vietnam in terms of assets (233.900million dated 31/12/2006), number of staff (about 30.000 employees accounting for40% of staff in the whole Vietnam bank system), branch networks(2000 branches),and customer base (15 million customers in every economic sectors)

Beside mandates in business, Agribank also displays its social responsibility

as a major enterprise to the cause of Social Security In 2009, Agribank conributed

to the building of dozens of school, hundreds of houses of gratitude and donatedthousands of gifts to the poor and the people who victims on natural disasters with

an amount up to hundreds of billions VND

Agribank is determined to maintain and confirm its leading and dominantpositions to provide loans for the cause of industrialization and modernization ofagriculture and rural development, economic development in conformity with thepolicies and objectives set by the Communist Party and the State

Besides, with a view to expanding Agribank’s network over Vietnam,Director Board discussed and decided to establish Agribank, Lang Ha Branch (Lang

Ha 22) March 18, 1997 Agribank, Lang Ha Branch was officially opened and cameinto operation according to Decision 334/QD-NHNN of Gorvernor of Agribank

Establishing Lang Ha Branch hightlighted the important breakthrough in proccess

of Agribank’s development, developed long term business plan, maintained ruralmarket and gradually controlled urban market

For 10-year performance, Lang Ha Branch set clear targets and gained greatachievements: fullfil over estimated plan, draw a lot of customers, meet firm’srequirements Lang Ha Branch has been regarded as the first flag and recognized as

a leading branch of Agribank

In 1997, Lang Ha Branch had 13 employees, December 31, 2008 there are

216 employees with about 8 postgraduates, 168 graduates from universities and 40graduates from colledges,

The scale of Lang Ha Branch doesn’t stop expanding, from Tier II, now thebranch inlcludes 2 Tier II and 10 transaction offices

1.1.2 The organizational structure of Agribank, Lang Ha Branch

Figure 1.1: The organizational structure of Agribank, Lang Ha Branch

DIRECTOR

DEPUTY

DIRECTOR

DEPUTYDIRECTOR DEPUTY DIRECTOR

Genneral Accounting Department

(Source: http://www.agribank.com.vn)

As the figure 1.1 shows that Lang Ha branch includes one director, three deputy directors and nine departments and six transaction offices in which the director is supported by the deputy director and then the director operates directly the whole activities of the bank Each department has separate functions but

combines with each other very smoothly to gain the best business results As to credit activity, the director and three deputy directors are responsible for

establishing credit policy and credit management regulation Especially, the credit department takes charge of the following tasks:

 Establishing and constructing capital transfer model and credit management efficiency

effectively

1.2 Overview of business activities in Agribank, Lang Ha Branch 2008-2010

In recent years (2008-2010), the business performance of Lang Ha Branch has fluctuate with challeges and opportunities Lang Ha Branch has strived to

overcome challeges and used up opportunities There are also some achievements gained and limitations occured in the recent years

 Capital mobilization

Capital mobilization is considered to be the top concern and the top task for all banks to expand business scale and dorminate in market Consequently, Lang Ha Branch takes special consideration on this activity and comes up with proper promotion programes to draw various types of customer

Figure 1.2: Total capital of Lang Ha Branch in 2008, 2009, 2010

Table 1.1: The increasing number of total capital in 2007, 2008, 2009, 2010

Money unit: VN million

According to the Figure 1.1, dated on December 31, 2008 there is 6463 million VND of total capital Seeing the table 1.1, In comparion with 2007, the totalcapital in 2008 decreased by 812 million VND because Bach Khoa and My Dinh transaction offices were separated from Lang Ha Branch But the total capital of

2007 is calculated except from that of two offices, the total is 5180 million VND Thus, the capital growth still stands at the speed of 124.7%

In 2009, the total capital increased to 7656 million VND, increased by 638 million VND equal to 110% of December 31, 2008

In 2010, there is a supprising number of 9888 million VND of total capital,

which makes a big gap in comparison with that of 2009 The total capital increased

to 2232 million VND and accounts for 129% of the total capital calculated in

December 31, 2009, reached to 147% as planed in 2010

In conclusion, the total capital of 2008,2009,2010 is considered to go up and

be stable, even reached over the plan expected by Vietnam Agribank

Table 1.2: Capital mobilization structure based on public sectors.

Money unit: million VND

(Source: business report of 2008,2009,2010 in Agribank, Lang Ha Branch)

In general, the rate of capital mobilization based on public sectors has been quitestable in recent years The table 1.2 shows that the capital mobilized from businesspersona has trend of rising over years from 63% to 66% and accounted for majority

of total mobilized capital However, it is seen that the capital source fromhouseholds slides down from year to year, just 32% in 2008 and 26% in 2010, underestimated plan by State Bank ( 42% of the capital mobilized from households).Obviously, the table shows that Lang Ha Branch mainly focus on business persona

 Credit activity

As expressed in the table 1.3 and Appendix 1, December 31, 2010, the totalaccount outstanding reached 4.201 million VND, increased by 658 million VND equal

to 132% of 31/12/2009 Includes :

- The outstanding for local currency reached 3634 million VND, increased

by 486 million VND, accounted for 129% of 31/12/2009, 116% of the plan in 2010

- The outstanding for foreign currency (conversed) was 567 million VND,increased by 172 million VND, equal to 144% of 31/12/2009, 10275% of the plan

in 2010

- The short-term outstanding: 1395 million VND went up by 297 millionVND than 31/12/2009, 52% of total outstanding

- The medium-long term outstanding: 2,806 million VND, increased by361million VND than 31/12/2009, 48% of total outstanding

(Source: Business report of Agribank, Lang Ha Branch in 2008,2009,2010)

Table 1.4: Financial result for 3 years

Unit: million VND

Table 1.3: Account outstanding of Agribank, Lang Ha Branch over years

Money unit: VND million

Year 2008 2009 2010

(Source: Business report of Agribank, Lang Ha Branch in 2008,2009,2010)

The table 1.4 indicates that for 3 years, the total inflows increased a little bit,but it is said that the figure did not move because the outflows also increasedwith the incomings It indicates that Agribank, Lang Ha Branch did not move,but it leveled off in recent years It is neccessary to motivate business activity ofAgribank, Lang Ha Branch

Based on above analysis on business activities in Agribank, Lang Ha Branch2008-2010, it is indicated that there are nothing new for Agribank development

in general and credit activity in particular In general, the credit activity isconsidered to stand at one level in spite of having signal of rising but unclearand very slow The increasing of total account outstanding goes with theincreasing of credit risk.The point shows that there are something needing to bemotivated in credit activity which enhances the quality of credit risk It issupposed that Lang Ha branch needs to draw certain plan to evaluate the quality

of credit risk management It is likely that the credit staff negflected potentialcredit risks Therefore, currently, reducing credit risk along with increasing totaloutstanding over years is targeted tasks for Agribank, Lang Ha Branch

1.3 The key term definitions

Following are some key terms that will be frequently mentioned in thereport:

1.3.1 Commercial bank

A commercial bank (or business bank) is a type of financial institution and intermediary It is a bank that provides transactional, savings, and money market accounts and that accepts time deposits (www.wikipedia.org).

Another definition about commercial bank of Charlotte Mission (2006) is

commercial bank is a bank that “accepts monetary deposits, process loans, and

provides other financial services, such as international banking, documentary collection, and trade financing” And the most common concept about commercial

bank that many people accept is that commercial bank is a type of financialinstitution and intermediary that accepts monetary deposit from economicorganizations and households It also accepts process loans and provides a lot offinancial services like international payment, documentary collection, and tradefinancing

1.3.2 Credit risk

Credit risk is an investor’s risk of loss arising from a borrower who does not make payments as promised Such an event is called a default Other terms for credit risk are default risk and counterparty risk (www.wikipedia.org).

1.3.3 Outstanding loan

An outstanding loan is the portion of the loan that has not been paid As payments are applied towards the loan balance, the amount outstanding decreases, the lower the interest rate, the faster the balance declines when payments are made.

(http://www.ehow.com/facts_6885935_definition-outstanding-loans.html

1.3.4 Bad debt

A bad debt is an amount that is written off by the business as a loss to the business and classified as an expense because the debt owed to the business is unable to be collected, and all reasonable efforts have been exhausted to collect the amount owed This usually occurs when the debtor has declared bankruptcy or the

cost of pursuing further action in an attempt to collect the debt exceeds the debtitself

The debt is immediately written off by crediting the debtor's account and thereforeeliminating any balance remaining in that account A bad debt represents moneylost by a business which is why it is regarded as an expense

(http://en.wikipedia.org/wiki/Bad_debt)

1.3.5 Overdue debt

A debt becomes an overdue debt once it is due and outstanding, providedthat it is certain, liquidated, due and payable Once a debt is overdue, the creditorcan collect it, either personally or through an agent A debt is overdue as soon aspayment is late It must be remembered that once payment is late, even by as little

as a single day, the law considers the debt to be overdue The debtor is in breach,because he failed to fulfill his obligation by the deadline There is no difference inkind between late payment and an overdue debt Late payment is a kind of overduedebt

1.3.6 Doubtful debt

Doubtful debts are those debts which a business or individual is unlikely to be able

to collect The reasons for potential non payment can include disputes over supply, delivery, and conditions of services or the appearance of financial stress within a customer's operations

1.3.7 Credit Risk Management Efficiency

Credit risk management in commercial banks means that the bank installs

and uses set of methods to control credit quality and reduce credit risk The creditrisk management includes: risk identification, risk analysis, risk measurement, riskcontrol and prevention, risk support

Credit risk management efficiency is the result achieved on the basis of full

implementation and proper measures in the activity of credit risk management

CHARPTER II: OVERVIEW OF CREDIT RISK AND CREDIT RISK MANAGEMENT EFFECIENCY IN COMMERCIAL BANKS

2.1 Commercial Bank

2.1.1 The concept of commercial bank

Economists are awared that commercial bank is an important financialorganization working as key role of the economy In economy growth,especially bank system, there are many types of banks, but the commercialbank dominates as a largest part , even in property scale Based on businessacitivies and banking service, commercial banks are clarified into differenttypes

According to America Law: A commercial bank (or business bank) is

a type of financial institution and intermediary It is a bank that provides

transactional, savings, and money market accounts and that accepts time deposits The commercial bank takes over many more tasks in comparision with any business in economy.

According to Bank Act and credit institution in Vietnam: “the bank is

intermediary which takes in charge of banking acitivities and related business” the banking acitivities mentioned as banking service included “ monetary deposits, process loans, and provides other financial services, such

as international banking, documentary collection, and trade financing”.

In summary, the commercial bank is a type of monetary business withfollowing tasks of capital mobilization for loans, investment, and otherfinancial tasks

2.1.2 Business activities of commercial banks

2.1.2.1 Capital mobilization

The capital mobilization makes capital source for the commercial bank Itplays an important role in business activities of the bank and affects thequality of banking activities There are a lot of capital sources but customerdeposit (from individual and business) accounts for the majority of allsources of the bank

To enhance amount of deposit in strongly competitive environment,banks carry out a lot of capital mobilization service such as: savings account,payment deposit, time deposit Besides, the commercial banks also createmoney by lending State Bank, the other bankers and lending in capitalmarket In addition, capital source is added with sources such as investment

trust, lending trust, disbursement trust and credit collection, etc sources inpayment such as cheque payment, security deposit to open L/C.

2.1.2.2 Credit activities

According to Mishler and Robert (1995), credit is defined as “a contractual

agreement in which a borrower receives something of value now and agrees to repay the lender at some date in the future; generally with interest” Credit is also

defined as the following definition in the website wikipedia.org:

Credit is the trust which allows one party to provide resources to another party where that second party does not reimburse the first party immediately (thereby generating a debt), but instead arranges either to repay or return those resources (or other materials of equal value) at a later date The resources provided may be financial (e.g granting a loan), or they may consist of goods or services (e.g consumer credit) Credit encompasses any form of deferred payment Credit is extended by a creditor, also known as a lender, to a debtor, also known as a borrower (www.wikipedia.org).

There are a lot of different definitions about the credit concept but it isconcluded that the nature of credit is the transaction of asset based on the basis ofrefund And from the above definitions of credit, we can work out some followingcharacteristics of credit:

 Properties for transaction in the bank credit have two forms of lending (incash) and leasing (real estate, personal property);

 Starting from the principle of refund, the lender transfers the property forthe borrower, they entrust and believe that the borrower will repay ontime This is very basic principle of credit management

 The borrower must repay unconditionally to the lender after expiry of thecontractual agreement and the return value is usually greater than thevalue of the loan at the beginning because of the interest.

Commercial banks take part in the credit relationship with both two roles: aborrower and a lender As a borrower, the banks will raise the free capital fromsocial organizations, individual by many ways like issuing bond, issuing valuepaper, savings, etc As a lender the banks meet the demand of organizations,enterprises, or individual when they need money for doing business or investing inproduction At that time the banks’ role is to supply capital, currency to re-produce.This is the major form of credit in the economy and the banks always meet capitalneeds for the society quickly and flexibly

2.1.2.3 The other activities

Besides two main activities (capital mobilization and credit activity), thecommercial bank also performs many other services such as security investment,foreign exchange, budget management, payment service,

2.2 Credit Risk Management in commercial bank

2.2.1 The concept of risk and credit risk

The concept of “risk” is diversely definited by economists, but it isconvinced that the risk appears when the unexpected incident which brings damages

to the certain business occurs, the risk might happen in any business withoutdepending on human awareness

Credit activities are one of the most important activities in the bank; and theymake the most profit for commercial banks but also have large potential risk.Statistics and studies show that credit risk accounts for about 70% of the bank’srisk Any bank’s mangers also do not want their bank to face the risk, so when they

offer any loans to customer, they have to analyze all of the customer’s factors Thebank only determines to grant the loans when the risk is very small

The risk is unavoidable and it only is limited to a certain level There aremany different definitions of credit risk As the opinion of Thomas P Fitch (2000)credit risk is the risk occurs when the borrower cannot repay the debt under thecontractual agreement that leads to the wrong date of the repayment obligations.Along with the interest rate risk, credit risk is one of the major risks in the lendingactivities of commercial bank The other credit risk definition by Van GreuningHenie and Sonja Brajovic Bratanovic is that credit risk is the risk when theborrower cannot repay interest or principal compared with the fixed time in thecontract Specified in the Clause 2, Article 1 of desicion number 493/2005/QD-NHNN by the Governor of State bank about debt clarification “ the credit risk inbusiness activities of banks is potential risk bringing damages for banks whencustomer cannot pay their debt as they commited” Any business which makesprofit, also includes potential riskiness Thus, Credit risk is that the repayment isdelayed or the repayment cannot be paid That causes problems for the capital flowsand affects the bank’s liquidity It can be said that credit risk is one of the mostpowerful risk in banking activities When the bank can reduce the credit risk andmanage the risk to the appropriated rate, it is regarded as the bank success and thecredit risk management is effective

2.2.2 The types of credit risk.

According to Decision number 493/2005/QD-NHNN about debtclarification, provision fund for credit risk made by Gorvernor of State Bank andDecision number 636/2007/QD-NHNN, debt is clarified into 5 groups Debtclarification is based on Article 6 (debt clarification in quantative method) orArticle 7 (debt clarification in qualitative method) Howerver, debt is also divideddepending on the causes of credit risk According to Phan Thi Thu Ha (2009)basing on the causes of credit risk, the credit risk can be divided into followingtypes:

Transaction risk includes selection risk, security risk, operation risk Transaction

risk is the risk to earnings or capital arising from problems with service or product delivery Transaction risk exists in all products and services In banking service,

transaction risk is the risk of direct or indirect loss resulting from inadequate or

failed internal processes, people and systems or from external events The main

causes for transaction risk can be:

Credit risk

Portfolio risk

Selection

risk

Security risk

Operation risk

Systematic risk

Unsystematic risk

The inadequate information system can result from general risks or from applicationoriented risks The general risks can include physical access to the hardware, logical

access to the information and communication technology systems, emergency management or from an insufficient backup recovery measures-mitigate the

consequences of system failures

Portfolio risk includes both systematic and unsystematic risk Systematic risk is risk

that impacts the overall market; for example, inflation, interest rate changes, or economic conditions Systematic risk cannot be eliminated but can be managed by hedging with derivatives or short selling Unsystematic risk can be eliminated through diversification

Unsystematic risk, such as product defects or management turnover, is unique to individual securities

2.2.3 Credit risk characteristics

In order to actively prevent credit risks effectively, identifying thecharacteristics of credit risk is very necessary and useful Credit risk has somefollowing basic characteristics:

 Credit risk is indirect It often occurs because of the customer’sbusiness activities

complexity of the causes, forms and the consequences of credit risk tothe bank because commercial bank is characterized as a financialintermediary in trading currency

connects closely with the credit activities of commercial bank

2.2.4 The causes and criteria to assess the credit risk

2.2.4.1 The causes from bank.

Credit policy is the backbone of credit activity in commercial bank Thecredit policy becomes common direction for bankers and credit staff to follow,creates a consistent way of carrying out credit activity to enhance credit quality Thebasic content of credit policy includes customer policy, scale policy and creditscope, credit profit and cost, policy of credit deadline and debt term, policy ofcollateral types, disbursement and payment condition and policy for doubtful asset.The credit policy is not suitable with economic context, which makes mistake incredit decision and leads to credit risk

Expanding credit over its limit also leads to increase credit risk in the bank.The main reason is that the credit staff doesn’t clarify enough carefully theircustomers, their supervision ability to loans becomes weaker It is the samemeaning with loosening credit procedure

In addition, there are various types of business requiring bank loans, thecredit staff cannot have enough knowledge in all types of business whichbusinessman intend to invest in Moreover, it is difficult for them to evaluatefinancial figures supplied by the firm: fake or right It is doubtful that the credit staffuses and analyses fake figures which are used for making financial appraisal andthen taking final credit decision

Another side, it is obvious that the staff with low qualification affects on thequality of evaluation If there is unclear evaluation, the number of bad debt willoccur, and then the credit risk will increasing Besides, some credit staff helps thefirm to make fake loan document for corruption, which causes to a large deal ofcredit risk in stage of disbursement

2.2.4.2 The causes from customers

The customers are enterprises who have few of experiences and low businesscapacity, they cannot update fast information to adapt newly competitiveenvironment Therefore, if the project of the firm faces with a lot of difficulties, thefirm won’t pay debt for the bank, the bank will bear credit risk Majority of theenterprises have intention of borrowing from the bank to expand business scale andimplement a new business plan, but don’t update new management method,business direction, to fit with new business scale and then causes business failure.Sometimes, the firm draws unproper business direction, which makes their productsinto slow sales, being at loss, the firm is unable to pay loans for commercial bank

Besides, Vietnam enterprise with small economic scale and high rate of debtover capital becomes more and more popular Plus, they provide fake data andfigures so the bank faces with difficulties in credit risk management

2.2.4.3 The causes from external environment

There are a lot of causes from outside environment that put the commercialbank in the difficult situation and lead to customer cannot repay the loans to thebank

 Due to the natural disasters, epidemics, or fire, etc

 Due to the turmoil security situation in domestic and regional area

 Because of the crisis, inflation, loss of balance of international payment, orthe fluctuation of foreign exchange rate, etc

 The legal environment is not favorable, macroeconomic management isloose

2.2.4.4 Criteria to assess credit risk

In order to assess the quality of credit risk, commercial banks often based onthe indicator of overdue debts and classification of debt

In the book titled “Commercial bank management”(2004) written by PeterS.Rose, it supposed that overdue debts are the debts occurred when the borrowerscould not repay for the bank on time Overdue debt can be calculated by thefollowing equation:

Overdue outstanding loanOverdue debt rate = x 100%

Total outstanding loan

It is regulated by State bank that overdue debt is alarming with over overdue rate of5% Based on that regulation, the bank will calculate their credit risk level overyears and scratch plans for reducing overdue debt rate to safe rate

Under the Decision No 493/2005 by State bank dated 22/04/2005 and theDecision No 636/2007 by State bank dated 25/04/2007 by Governor, the institutionsclassify debts into 5 groups as follows:

safe debt, the bank is likely to be paid both original debt and interest on contracted time.

 Debts are overdue 90 days

 Debts needed expanding maturity time

 All debts is regulated into group 2 in Article 3 and Article 4 of Decision 493

 Debts are unpaid from 90 days to 180 days

 Debts are lasted more 90 days

 All debts is regulated into group 3 in Article 3 and Article 4 of Decision 493

 Debts are overdue from 181 days to 360 days

 Debts are expanded maturity time from 90 days to 180 days

 All debts is regulated into group 4 in Article 3 and Article 4 of Decision 493

 Debts are overdue 360 days

 Debts are waiting for Government decision

 Debts are expanded maturity time more 180 days.

2.3 Credit Risk Management efficiency in commercial banks

2.3.1 The definition of Credit risk management

Credit risk management in commercial banks means that the bank installs

and uses set of methods to control credit quality and reduce credit risk The creditrisk management includes: risk identification, risk analysis, risk measurement, riskcontrol and prevention, risk support

Accoring to José M Pastor and Lorenzo Serrano, Business management

efficiency means minimisation of costs and maximisation of profits So the credit

risk management effeciency means reduce credit risk at minimum and increase

profit from credit activity at maximum

2.3.2 The importance of credit risk management in commercial bank.

As to economy, the occurrence of credit risk delays production progress,bankrupt, shortage of product supply for market In some point, it makes the price

go higher and higher, which is called inflation An addition, when one bank goesbankrupt, it is easy to cause bankruptcy in the whole bank system and instabilityinto monetary market Especially, in the current context of the economy, paymenttransactions in every firms depend on banking services and are done through banks,

so if the bank faces up to credit risk, every transaction is postponed and the proccess

of capital transfer in firms are interrupted It means that business profit will godown To sum up, the credit risk makes imbalance in monetary market, businessinteruption Therefore, it is very important for economy to have good credit riskmanagement

As to customers, it is said that the credit risk results from business risk of thecustomer The debt of the customer becomes bad debt of the bank As a result, theyare no longer supported by the bank with financial investment, and lost opportunity

in business, even go bankrupt

As to the bank, the credit risk becomes a dangerous signal, it makes the bankface up to weak solvency, lower profit and reputation with customers.Consequently, the bank always looks for solution to improve credit quality and findthe way how to manage the credit risk to avoid the occurrence of the credit risk

2.3.3 The Basel’s principles of credit risk management in commercial banks

According to the book titled “Principles for the management of credit risk”(Basel, 2000); all the members of the Basel Committee agree to build the principlesincluding 17 principles to evaluate the bank’s credit risk management system.(Appendix 2)

2.3.4 The credit risk management efficiency

2.3.4.1 Definition of credit risk management efficiency

Credit risk management efficiency is the result achieved on the basis of fullimplementation and proper measures in the activity of credit risk management.These results include:

 Classifying appropriately the customers Lending to the right customer

 Identifying the signals comprehensively

debts become the bad debts and bad debts become the loss debts

2.3.4.2 Criteria to assess credit risk management efficiency

Credit risk management efficiency is manifested in two criteria: quantitativecriteria and qualitative criteria

Firstly, basing on quantitative criteria, the management of credit risk iseffective when the outstanding loans increase and

+ Bad debt rate/ outstanding loans = R

+ Bad debt rate/outstanding loans decreases compared with the previous years

In the above equation R is the percentage of bad debt divided by outstandingloans that the bank expected and R is the highest rate that the bank can accept

Secondly, in term of qualitative criteria, the management of credit risk isevaluated successfully when it can improve the bank’s prestige The effective creditrisk management not only helps the bank minimize the loss but also enhances thebank’s prestige and gains customers’ confidence The commercial bank activitiesare very sensitive, so if the bank gains the customers trust it can operate well but incontrast if it loses the prestige it will easily to face the bankruptcy

2.3.4.3 Factors affecting the credit risk management efficiency

There are many factors that affect the quality of the credit risk management,but we only examine some basic factors Firstly, it is the level of accuracy and howthe bank updates the customers’ information in a credit relationship This is themost important factor that can deeply affect to the quality of credit riskmanagement In the management of risk activity, identifying the signals of risk isextremely important It requires collecting a lot of customer’s information Whenhaving exact and full information of customer, the bank will understand deeplyabout the condition of credit to make timely decisions in managing credit risk

Because some customers have inability to pay for the bank when they don’t makemoney from business activities It will put the bank in danger when the bankdecides to allow customer to make loans without analysing their business plan.Therefore, it is vital to analyse customers’ information to limit risk in creditmanagement.

The second factor is the capacity of receiving, handling, and analyzinginformation effectively to make accuracy decision about the bank’s loans Whenhaving the customer’s information, the credit officers have to analyze, select theimportant information related to the customer’s solvency The credit officers’ levelwill affect much about the decision whether or not accurately Therefore, it is veryimportant for credit officers to improve their knowledge about the society, theability of analyzing and handling information

Besides, the bank’s policies, the capacity of the board director of thecommercial bank also affects much about the quality of credit risk management.When the bank’s policies are appropriate that will facilitate credit officers insupervising, monitoring credits And if the board director of the bank has goodcapacity they will have timely and accurately decisions about the credits Otherfactors that also affect the quality of credit risk management are the morality ofcredit officers, business environment, market condition, the political environment,etc So, in order to improve the credit risk management efficiency it is important tounderstand more about the above factors affecting the quality of credit riskmanagement

CHAPTER III: ANALYSIS AND FINDINGS ABOUT THE REALITY OF CREDIT MANAGEMENT EFFICIENCY AT AGRIBANK, LANG HA

x100% < 5%

 Credit risk rate = total outstanding loans/ total assets

The fact is that the higher these rates, the higher profit and it also mean that thehigher credit risk

3.1.1 Overdue debt

Figure 3.1: The reality of overdue debt and overdue debt rate of Agribank, Lang

Ha Branch in the period of 2008-2010

(Source: Business report of Agribank, Lang Ha Branch in 2008-2010)

The overdue debt has trend of rising from 2008 to 2010 In 2008, the overduedebt accessed to 55 million VND, and stood at 2.61% In 2009, it is surprising thatthe rate reached to 2.90% equal to 70 million VND In 2010, the overdue debtincreased up to 83 million VND, accounts for 3.10%

The overdue debt based on term

Table 3.1: The overdue debt in Agribank, Lang Ha Branch